So, picture this imaginary future. President Bush's partial privatization plan was enacted. People have been socking away funds in individual accounts for years. Social Security benefits have eroded continuously, as was inevitable under President Bush's plan. People will have adjusted their consumption and savings to leave themselves with savings that they expect to be sufficient for retirement.

Then, bang! After people have retired or become disabled, or just on the eve of claiming benefits, a financial panic they could not possibly have anticipated strikes. Even worse, stock prices collapse as much as they did in 2001 when over-the-counter shares fell roughly 80 percent and the New York Stock exchange fell by more than 40 percent. Those are the assets in which private accounts were invested. Retirement income, once thought adequate, becomes insufficient. To be sure, Social Security benefits would remain, as they are today, rock solid. But under the typical privatization plan, they would provide much less of retirement income than they do today. The financial crisis would become a personal calamity for tens of millions of retired baby-boomers and their successors.

To be sure, current market conditions aren't what you would use to advertize personal retirement accounts. People retiring today have had to weather both the current sub-prime crisis as well as the unwinding of the tech bubble earlier in the decade.

That said, I'm wary of generalizations like this lacking numbers. I'm working to put numbers to these questions and suspect they may tell a somewhat different story.

3 comments:

jg
said...

It's important to remind people that much of the Democratic Party has long embraced investing the so-called trust fund in the stock market. The difference with a declining stock market is whether individual accounts get hit or government accounts, but in the long run the difference might not be that great.

Under a 2005 proposal from Robert Ball, author of the plan that represents the closest thing there is to a liberal framework for SS reform, if returns from investing the trust fund were disappointing, then payroll taxes would have to be hiked further to compensate.

Whenever the size of the trust fund declines in relation to Social Security’s annual cost, Ball’s 2005 plan would raise payroll taxes to make sure the trust fund doesn’t become depleted. If stocks perform as well as hoped, his plan would impose a 1% hike in the payroll tax rate (to 13.4%) in 2023. But if stocks only perform as well as Treasuries, his plan would call for a 1.8% payroll tax hike (to 14.2%) in 2021, according to the Social Security actuaries. If stocks perform worse than Treasuries, the payroll tax hike could be larger and come sooner.

It’s also important to note that with personal accounts, individuals would have the discretion to decide how much, if any, stock exposure they want. But government investment of the trust fund would presumably be 100% in equities.

Good point. Aaron has favored collective investment of the trust fund in stocks. It's always assumed that with collective investing the risk somehow goes away, but that's not the case. If the market drops then social security goes insolvent earlier than predicted, which leaves those cohorts in the lurch.

I probably should have mentioned that some Democrats also support add-on accounts, which also would expose individuals to risk.

Some Democrats have supported add-on accounts because the alternative -- a straightforward payroll tax hike -- is likely even less politically popular. I don't think there's been polling on this topic, but I strongly suspect that individuals would rather save add-on contributions in an inheritable account, rather than simply sending that money to the government.

Those opposed to personal accounts also tend to be opposed to benefit cuts. But -- as Obama's retreat on SS makes evident -- it's not politically or economically feasible to save Social Security only by raising taxes on the rich. So those who aren't simply trying to demagogue the issue need to say that they want to raise payroll tax rates, send that money to government and make it even harder for low-income Americans to build up financial assets.

The constructive discussion regarding personal accounts for those serious about Social Security reform should be what degree of risk is manageable and how can we limit risk (especially for modest wage-earners) while still providing ownership.

About me

I am a Resident Scholar at the American Enterprise Institute in Washington, where my work focuses on Social Security policy. Previously I held several positions within the Social Security Administration, including Deputy Commissioner for Policy and principal Deputy Commissioner. Prior to that I was a Social Security Analyst at the Cato Institute. In 2005 I worked on Social Security reform at the White House National Economic Council, and in 2001 I was on the staff of the President's Commission to Strengthen Social Security. My Bachelor's degree is from the Queen's University of Belfast, Northern Ireland. I have Master's degrees from Cambridge University and the University of London and a Ph.D. from the London School of Economics and Political Science. I can be contacted at andrew.biggs @ aei.org.